Keep a good focus on emerging markets

By Michael Ranis, October 28, 2009

Shanghai: attracting smart investors

China? Brazil? India? What has the world come to that these are the countries that seem to attract investments from all corners? Is the elevated status of emerging markets just a fashionable concept, or is this the embodiment of a massive transition?

Does it reflect on “the decline of the West” and a rise of new, far-away powers, or just some mirage that will soon fade?

Let us consider a few facts:

● It is quite possible that my children (aged 16 and 20) will see China’s GDP surpass that of the USA. It is equally likely that they will see the combined economies of Brazil, Russia, India and China (the famous BRIC countries) surpass in size the combined economies of Europe and the USA. Whether we like it or not, that is real, inexorable, change and it commands our attention.

● Though we tend to have a derisive view toward “third-world” countries, a view that sees them as corrupt and disorderly entities, we need to recognize that, at least in some of them, there has been a significant transformation toward adopting western concepts regarding law, property and information.

● Politically, most of the emerging market world may have improved, but the improvements are limited and still provide plenty of reasons for concern. This is probably the gravest achilles heel for investors in emerging markets.

● Most emerging markets are facing disturbing problems, in part stemming from their rapid growth. We have all seen the worrisome pictures of overpopulated cities, pollution, traffic bottlenecks, large disparities between rich and poor. It is not always clear how these problems will affect investors and their choices, but we need to be aware of them.

What is one to do about all of this as an investor? It seems to me that we must begin but taking a fresh look at our portfolios. Do we give enough weight to these markets? I do not think that I am too far off the mark if I claim that in most portfolios, the weight of all equity and fixed income exposure to emerging markets is significantly below 20 per cent of total assets. That said, depending on the risk tolerance, I have seen allocations of up to 40 per cent.

For those who are less willing to invest in such markets, a valid strategy should be to identify proxies: companies whose business are likely to profit from the exponential growth in these economies. That approach has some significant benefits and curtails some, but surely not all, the negatives. The bottom line is that this is a much more interconnected world, and our investments should reflect this.

Michael Ranis is the Chief Investment Officer at Bank Hapoalim, London Branch